The Economic impact of environmental regulations

Posted on Monday 26th April 2010

For many years the conventional wisdom has argued that increasing the stringency of environmental regulations such regulations will damage industrial competitiveness. Perhaps the most famous example of this viewpoint is provided by George W Bush’s refusal to ratify the Kyoto Protocol climate change agreement on the grounds that to do so would damage US competitiveness.

A significant body of work, much of it undertaken at the University of Birmingham, now questions this conventional wisdom. If stringent regulations (relative to those in the developing world) have damaged the competitiveness of the manufacturing sector then we would expect this to be reflected in international trade and/or foreign investment flows. For example, in a country with stringent regulations we might expect to see declining net exports in certain pollution intensive industries or increasing foreign direct investment to low regulation countries from those industries.

A large number of economic studies have tried to assess if differences in regulations do indeed influence trade or investment flows. The vast majority find no, or only very limited, evidence. A number of possible reasons for this lack of evidence have been suggested, including the fact that pollution intensive (high regulation) industries are typically physical capital intensive and not sufficiently mobile to relocate overseas to developing countries (where physical capital may also be relatively scarce). Also, most international trade occurs between developed countries which tend to have similar levels of regulations.

Furthermore, environmental regulation costs tend to be relatively low and are unlikely to exceed more than 2–3% of an industry’s total costs even in the most pollution intensive industry. Finally, it is possible that stringent regulations might stimulate innovation in firms which may actually enhance competitiveness (the so-called Porter Hypothesis).

Our recent work with colleagues in Japan has shown that that regulations do actually have a small influence on Japanese trade but only when the analysis focuses on (i) trade flows with the developing world only (ii) the most mobile pollution intensive industries and (iii) those pollution intensive industries with the highest regulation costs. This study concludes that regulations have no widespread effect on competitiveness but rather they affect only a very small subset of firms and industries.

At the level of the economy as a whole such impacts are likely to be relatively small. The lack of evidence of large scale competiveness effects is also supported by research examining the impact of environmental regulations on jobs. Our own recent research found no evidence to suggest that UK environmental regulation costs have had an adverse effect on manufacturing employment.

While regulations should be implemented carefully and in a cost-efficient manner, claims that they will have widespread economic impacts appear to be wide of the mark. When we also consider the significant benefits that we derive from environmental regulations, the cost-benefit analysis moves even further in towards a net benefit.

Matthew Cole
Professor of Environmental Economics
University of Birmingham